What is Cost to Serve

Devil in the Detail

A better understanding of supply chain cost dynamics can help companies recognise their profitable customers.

Many companies fail to recognise the true profitability of their customers and product/service mix. Traditional reporting methods aggregate revenues and costs to the extent that poorly performing sectors of the business are hidden from view.

Cost To Serve (CTS) enables companies to reduce cost and improve EBIT (earnings before interest and tax) performance by up to 20 per cent. Evaluating the benefits of CTS is a must for companies new to the concept.

 

What is CTS?

CTS is understanding the total cost of servicing individual customers and individual products so that the business can match service and cost, to achieve business goals. CTS is not about quantifying distribution cost as a percentage of sales, nor about knowing the cost of processing an order.

These common measures are generally based on aggregated data that takes no account of the unique needs and cost drivers of certain customers and product types within the supply chain.

It is a rare business that has such a limited range of products and customers that they can service their entire market with a generic service policy. Conversely, it would be rare for a business to incur similar costs for servicing what can be a complex matrix of customers and products. Unraveling this potpourri of information is what CTS is about.

Read More: Cost to Serve – A Smarter Way to Improve Supply Chain Profitability

 

Steps to CTS

There are five critical steps in undertaking CTS:

  1. Identify the characteristics of your customers and products. For example, typical order size, order frequency, geographic location, and brand support.
  2. Identify the cost drivers within the supply chain, such as: purchasing, storage, transport, customer service, sales, and account management.
  3. Determine cost allocation rules for each unique customer and product grouping identified.
  4. Conduct a trial data set through the model to test assumptions and results.
  5. Implement the CTS discipline and identify the areas of opportunity to reduce costs and improve sales.

CTS typically highlights unprofitable products and customers. This enables your company to reduce the CTS by adopting alternative approaches to servicing your customers.

Such approaches might include:

  • Changing market channels
  • Varying the service level to certain customers
  • Utilising lower-cost transport solutions for certain geographic locations
  • Re-balancing inventory across the business to improve service and reduce costs

Bottom-line benefits resulting from any of these actions can often be substantial.

 

A Word of Caution… 

The knee jerk reaction within many businesses when realising that certain customers and products have a negative impact on the bottom line, is to try to delete them from the range or customer base. This is the wrong approach.

However shocked you may be by the results of a cost-to-serve analysis, avoid the knee-jerk reaction and instead, use your new-found knowledge to turn unprofitable customers and products into profitable ones.

For example, let’s assume your company distributes packaged consumer goods, and that your CTS analysis identified that certain customers with complex service requirements were generating particularly low levels of profit.

Armed with this knowledge, you might approach those customers and offer them an incentive (such as discounted pricing) to accept less-frequent deliveries or perhaps to make adjustments that would reduce the custom work required to fulfill their orders.

 

Can You Afford Not to Know Your Cost-to-Serve?

Unless you have taken steps to understand your company’s cost-to-serve, it’s very likely that you have some customers and products that are unprofitable. It’s possible that some of them are even generating a loss (it’s not at all uncommon for this to be the case).

If you can change the behaviours, processes, and practices that make these customers and products (or combinations of the two) unprofitable, you should have no trouble realising positive ROI on a cost-to-serve analysis, even if you bring in external specialists with best-of-breed solutions to make the exercise more manageable.

If you’d like to learn even more facts about cost-to-serve and find out how Logistics Bureau has helped hundreds of companies reduce theirs, stop by at our CTS service page. From there, you can access other resources on the topic, including a downloadable report and a PowerPoint presentation.

Editor’s Note: This post was originally published in May 2004, and has now been revamped and updated with more comprehensive information.

 

Best Regards,

Rob O’Byrne
Group Managing Director
Email: [email protected]
Phone: +61 417 417 307